The Next Credit Problem: Underwater Car Loans

NEW YORK (Credit.com) — These days, a lot of attention is paid to the epidemic of underwater mortgages, but now experts believe it’s also a growing trend for Americans’ auto loans.

Underwater car loan balances — those for which consumers owe more than their car is worth — are becoming more common in the auto lending industry largely as a result of long-term financing, according to a study by Consumer Reports. In general, the longer an auto loan lasts, the more likely a person is to owe more money on it as the value of the vehicle depreciates.

Loan terms averaged 64 months in 2012, up from 63 in the previous year and 62 in 2009, the report said. These increases suggest consumers are now taking on more auto loans with terms of six or even seven years.

The problem with this is that in many cases, long-term auto loans are extended primarily to those with generally low credit ratings, the report said. Further, the rate at which lenders have been granting those with subprime scores auto financing has ticked up in recent years, to a total of 38% of all such loans issued for used vehicles last from 35% in 2009. A similar increase was seen for new car loans, which jumped to 13% from 10%.

Moreover, the study found that below-average buyers pay “extremely high interest rates” on the financing they get, which can range from 9.7% for a standard subprime loan for a new car to 17.7% for used-car buyers whose scores are so low they are considered “deep subprime,” the report said. These buyers might never be able to build equity with their vehicles, as even with low interest rates and a down payment of 10%, many borrowers find it difficult to do so.

Whenever a borrower opens a line of credit — for any reason — they should take the time to determine whether it’s a good investment. This can include taking steps such as weighing the terms of the loan and shopping around to see what else may be out there for them. Getting a line of credit with less than ideal terms can end up costing borrowers significant amounts of money over the life of the loan.